Reports Q2 Results In Line with Preannouncement

NetScout Systems (NTCT) reported fiscal Q2 ‘24 results consistent with its mid-October preannouncement. Recall that revenue fell short of our original expectations and consensus due to a slowdown in order conversions during the last month of the quarter. Per management, revenue from the service provider vertical was impacted by increased deal scrutiny among both cable customers and international service providers. In the enterprise vertical, customers in the financial services and healthcare sectors also delayed purchasing decisions, more than offsetting continued strength with government agencies. Despite the shortfall in revenue, both adjusted EBITDA and non-GAAP EPS exceeded our prior estimates and consensus due to higher gross margin and lower operating expenses.

For FY ‘24, management reaffirmed its lowered revenue and non-GAAP EPS guidance provided in the mid-October preannouncement. However, the outlook for Q3 implies the full year results will be heavily weighted towards Q4. We surmise that between typical seasonality and closure of deals that slipped from last quarter, results in Q3 could ultimately prove stronger than anticipated, which in turn would lower the hurdle for Q4. In other words, we believe management’s guidance reflects some conservatism in the timing of orders but should be achievable when all is said and done.

Given that we adjusted our estimates following NetScout’s Q2 preannouncement, we made only minor adjustments to our model. Our price target remains $38.00 based on an unchanged EV/EBITDA multiple of approximately 12x but now applied to our FY ’25 estimate. Although we are disappointed to see NetScout succumb to the elongated sales cycles experienced by many other technology vendors of late, we note that the company has preserved much of the profitability previously expected for the year without making significant reductions to headcount. As such, we believe the company remains well positioned for renewed growth and margin expansion as service providers resume investments in 5G network deployments and as NetScout’s expanded suite of cybersecurity solutions continues to gain traction.

Exhibit I: Quarterly Results and Guidance Versus Expectations

Sources: FactSet Estimates; K. Liu & Company LLC; NetScout Earnings Release

Q2 revenue of $196.8 million (-13.7% Y/Y) was consistent with NetScout’s mid-October preannouncement of $195.0-$197.0 million. Product sales totaled $80.5 million (-28.0% Y/Y), while service revenue was $116.3 million (flat Y/Y). Revenue from service assurance products comprised 66% of revenue and declined 23% Y/Y, while cybersecurity sales made up the remaining 34% of sales and increased 11% Y/Y. Similar to last quarter, the decline in service assurance revenue largely reflects the completion of Radio Frequency Propagation Modeling projects over the past year and coincides with a 12% Y/Y decline in revenue from the service provider vertical, which accounted for 46% of total revenue in Q2. In the enterprise vertical, which comprised the remaining 54% of revenue, revenue declined 15% Y/Y as heightened scrutiny of deals by customers in the healthcare and financial services sectors more than offset continued strong growth with government agencies.

Non-GAAP gross margin of 80.3% was above our 78.5% assumption due primarily to higher service gross margin. Total operating expenses were considerably lower than we modeled due to lower variable compensation across the company. As a result, both non-GAAP operating income of $55.2 million (28.0% margin) and adjusted EBITDA of $59.9 million (30.5% margin) beat our estimates of $48.8 million and $53.8 million, respectively. Non-GAAP EPS of $0.61 were in line with the company’s preliminary expectations for $0.60-$0.62.

Cash and investments at quarter-end totaled $332.6 million, while outstanding debt remained unchanged at $100.0 million. In Q2, NetScout used $26.4 million in cash for operations and had $1.5 million in capital expenditures.

Turning to the outlook, management reaffirmed its FY ’24 guidance, which was lowered in conjunction with the mid-October preannouncement. Management’s guidance continues to call for revenue and non-GAAP EPS of $840.0-$860.0 million and $2.00-$2.20, respectively. At the midpoint of guidance, Q3 revenue and non-GAAP EPS are expected to comprise 23%-24% and 17%-18% of the total for the year, respectively, implying expectations for $195.5-$204.0 million in revenue and $0.36-$0.38 in non-GAAP EPS. Prior to revisions, we were projecting $211.4 million in revenue and $0.55 in non-GAAP EPS, while consensus was higher at $216.7 million in revenue and $0.59 in non-GAAP EPS.

Exhibit II: Estimate Revisions

Source: K. Liu & Company LLC

We fine-tuned our revenue estimates for this year and next, which primarily entailed shifting revenue between products and services. We also increased our assumption for service gross margin, which was largely offset by slight adjustments to our product gross margin and operating expense projections. Overall, our estimates for FY ’24 and FY ’25 remain little changed.

Our report with model and disclosures is available here.

Disclosure(s):

The analyst, a member of the analyst’s household, and/or an account in which the analyst exercises discretion hold(s) a long position in the common stock of NetScout Systems (NTCT).